University of Twente Student Theses


Credit risk modeling and CDS valuation: an analysis of structural models

Beem, J.A.G. van (2010) Credit risk modeling and CDS valuation: an analysis of structural models.

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Abstract:The main objective of this thesis is to determine a credit risk model that could be used to value credit default swaps (CDSs). A literature study identifies that structural models are able to meet this objective and that they could also be used for analysis on default probabilities and recovery rates. Two structural models are selected for further research. In the first model the firm's assets value process is a jump-diffusion process and default is modeled as the first-passage of a constant default barrier. The second model uses the same jump-diffusion process for the firm value, but incorporates a mean reverting leverage process to model default. We implement both models in Matlab using (Brownian Bridge) Monte Carlo simulations to analyze the sensitivity of modeled CDS term structures to value changes in the input parameters. We find that both models can calculate non-zero short-term CDS spreads and that the second model generates upward sloping term structures over a long time horizon. From three cases studies in which we compare modeled CDS spreads to the market spreads of Dutch firms we find that an advanced parameter estimation methodology is necessary to provide consistent jump and diffusion parameter values throughout the economic cycle.
Item Type:Essay (Master)
Deloitte Capital Markets
Faculty:BMS: Behavioural, Management and Social Sciences
Subject:85 business administration, organizational science
Programme:Industrial Engineering and Management MSc (60029)
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